Dish Must Find Mojo Or Merge

Some on Wall Street are willing to bet that the only two satellite TV service providers in the U.S. could go the way of recently merged XM and Sirius radio, as long as both Dish Network Corp. and DirecTV can maneuver through economic tough times.

Despite heightened speculation, some argue that such a satellite TV alliance is highly unlikely, due to the monopoly that would be created in portions of rural America. "It would be a mistake to assume that the XM/Sirius merger makes a DirecTV/Dish merger any more feasible in Washington. The regulatory issues in the two mergers are entirely different," says Bernstein Research analyst Craig Moffett. At least for now. Regulators approved the satellite radio merger because it competes in a broader in-car and everywhere portable entertainment market.

By comparison, the absence of cable and telco service in many rural areas denies consumers their competitively priced choice. For now, the precedent set by satellite radio requires viable alternative television distribution models, such as TV over the Internet, which is only possible through a high-quality broadband connection provided by cable modem or telco fiber.



A satellite television merger of DirecTV and Dish would likely be denied by the Department of Justice and the Federal Communications Commission for the same reasons it was nixed the first time such a union was proposed in 2002.

Based on the most recent quarterly-earnings results, the more salient issue is whether Dish can stem subscriber losses and sudden negative subscriber growth before it hurts its bottom line. With price-sensitive consumers being squeezed everywhere, alternative video value was never more of a threat to the feisty satellite Dish network and its sister company EchoStar, forged by founding CEO Charlie Ergen.

Dish surprised industry analysts with higher-than-expected $869 million in adjusted second-quarter earnings on nearly $3 billion in revenues and 73 cents diluted earnings per share. But Dish also reported its first, albeit modest, subscriber losses on higher 1.87% churn. Gross subscriber additions are down 12% from a year ago. That has prompted Citibank analyst Jason Bazinet to slash his estimated for net subscriber additions for 2008 by 75% to just 6,000, while forecasting a 5% rise in $1.16 billion of capital expenditures. But he also raised his earnings-per-share estimates for the year by 13% to $2.47 EPS on improved margins.

While Dish is unable to alter some of the negative challenges it faces, it is righting itself in highly competitive seas. Dish's churn rate has moved steadily higher over the past four quarters. AT&T recently informed the company that it will opt out of its existing pact to resell satellite services in order to align with rival DirecTV--taking with it the 15% of gross subscriber additions it has generated for Dish so far this year. Lehman Brothers estimates that AT&T's partnership has a $3 billion asset value to Dish.

AT&T, once considered a Dish suitor, has been undercutting the satellite provider at every turn by calling for the payment of debt notes, reducing its marketing for the companies' bundled services and competing with its new U-Verse TV service. Dish and EchoStar were dealt another blow when an appeals court recently upheld a patent ruling favoring TiVo. Most analysts have removed a merger and acquisition premium from Dish's $18.6 billion equity valuation, based on the lack of subscriber growth.

That said, Bazinet believes Dish's churn rates and its bad-debt expenses can moderate. Its near-double-digit free cash flow yield could move higher, providing impetus for management to begin buying back shares in a depressed market. It may even invest in wireless broadband services. Dish has targeted more than 20 million TV households that it needs to convert to digital by the February 2009 conversion deadline.

Several months ago, analysts noted the accelerated pace at which Dish subscribers were defecting to the bundled plans offered by DirecTV, cable and telco rivals. Just after the company reported an 89% decline in year-over-year subscriber additions in the first quarter, Moffet was among those who asked whether Dish had "lost its mojo" and would be the next Sprint. Although Dish is posting solid financial results and healthy services per subscriber (ARPU), there is no denying its rapid fall from grace as the fastest-growing pay TV operator in less than a year.

Perhaps the most significant lesson from Dish's precipitous subscriber declines is how quickly a major media company has been caught in the gears of digital change. Dish and Ergen have been riveted on cost management and set-top box refinement, and distracted by lawsuits. Analysts say Dish does not have a bank facility in place to cover a $1.5 billion in debt maturities coming due before year's end and a $750 million in debt financing used to make an FCC payment. Dish has underestimated the importance of value-added HD and marketing to consumers as well as exclusive events, such as Nascar and professional football, that DirecTV offers. The companies' radically divergent paths now extend to different growth trajectories.

And it may be caught short again by DirecTV, which is controlled by John Malone's Liberty Media, one of the savviest strategic industry competitors. If there is a way for Malone to put Dish out of its misery and take over the entire satellite television shooting match, he will find it. Above all else, Malone has Ergen beat on turning adversity into gold.

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